Polaris Inc. (PII) Q4 2018 Earnings Report, Transcript and Summary

Good day, everyone. And welcome to the Polaris 2018 Q4 and Full Year Earnings Conference Call. [Operator Instructions] And please note that today's event is being recorded. And I would now like to turn the conference over to Richard Edwards, Head of Investor Relations. Please go ahead.

Thank you, Will, and good morning, everyone. Thank you for joining us for our 2018 fourth quarter and full year earnings call. A slide presentation is accessible at our Web site at www.ir.polaris.com, which has additional information for this morning's call. Today, you will be hearing remarks from Scott Wine, our Chairman and Chief Executive Officer and Mike Speetzen, our Chief Financial Officer. During the call, we will be discussing certain topics, which should be considered forward-looking for the purposes of Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projections in the forward-looking statements. You can refer to our 2017 10-K and 2018 10-Q for additional details regarding risks and uncertainties. Additionally, all references to fourth quarter and full year 2018 actual results and 2019 guidance are reported on an adjusted non-GAAP basis unless otherwise noted. Please refer to our Reg G reconciliation schedules at the end of this presentation for GAAP to non-GAAP adjustments. Now, I will turn it over to our CEO, Scott Wine. Scott?

Thanks, Richard. Good morning, and thank you for joining us. It's a little chilly in Minneapolis today but in the city around here is not to whether it's how you dress for it. Weather is certainly a consideration for Polaris although, from the economy and tariffs to currencies and competition, we include many more important and less predictable factors in our planning. Looking back at 2018, I'm extremely proud of the execution of our Polaris team as we profitably grew revenue, gained market share and met guidance despite many external variables working against us. Clearly, our operational and competitive success was not rewarded by the market, which left me feeling a bit like Ohio State or Central Florida, whose accomplishments were not appreciated by the college football selection committee. We're being judged less on the financial performance reflected in our win loss record and more on our week schedule, if you will namely, the perspective impacts of tariffs and a slowing economy. This was most evident on December 4th when a tweet about a tariff man coincided with the inversion of the yield curve and our stock dropped 10%. We are keenly aware of these macro issues and are escalating our focus on strong execution to deal with them in the year ahead. Fourth quarter sales and adjusted net income were both up 14% with 4% organic growth augmenting the incremental sales from both through the period. We did see a drop off in dealer traffic and retail sales in the second half of December, which has since recovered nicely in January but did reduce our yearend shipment as our RFM system appropriately reacted to the slowdown. Exceeding $6 billion in revenue for the full year was a nice milestone. And while both added nearly $280 million to that number, strong core growth in Europe, Parts, Garments, and Accessories and of course, off-road vehicles contributed even more. Sales are important but we are much more focused on expanding net income, which was up 28% year-over-year. Fourth quarter North American retail sales were up 6%, outpacing our full year performance of plus 4% with snow performing exceptionally well in both periods. Off-road vehicle retail sales were up modestly in the quarter as continued strength in side-by-sides offset declining ATV in retail. With strong product news, innovative marketing and crest promotional and sales execution for both RANGER and RZR, we returned to market share gains and moderate retail growth in side-by-side for the quarter, and both ATVs and side-by-side gained share for the full year. Motorcycling retail was weak in the quarter but Indian continued to gain market share, leading to modest growth and expanded share for the full year. As always, vehicle and product innovation contributed to our retail success. But in 2018, our investments in digital marketing, lead management and dealer engagement really began to pay dividends, both retail grew slightly in Q4 gaining market share and a light quarter for the industry. The Polaris vision of fueling passion and enriching lives transcends our annual operating plan. And taken together with our commitment to being a customer centric highly efficient growth company, it provides a constant guide for our investments in all that we do. Our highlights from 2018 demonstrate that we put our actions behind our words. Winning in the competitive Powersports industry is difficult, but gaining market share from a clear number one position is much harder. We did that in 2018 with ballpark innovations in every business, but also impressive improvements in performance, quality, styling and even product delivery. RFM is proving to be a sustainable competitive advantage and importantly, its capabilities are enabling factory choice, which dealers and customers deserve and expect. Horsepower to the ground is a term our engineers like to use, and I'm proud the way our entire organization is embracing it. We design our manufacturing plants to operate efficiently, but it only counts if we deliver the right vehicle, the right quality, the right performance, the right safety and even the right color at the right time to our dealers. We did that over 90% of the time in our busiest months of the year and full year delivering metrics were better than ever before. And for flat-track racing to hill climbs and off-road races of all types, Polaris and Indian reign supreme at putting horsepower to the ground, winning races with unprecedented success. Celebrations extended beyond the track as we commemorated RANGER's 20-year anniversary, and we built our 100,000 Indian motorcycle engine. The teams behind these brands are top notch and the products they build are outstanding as well. Customers can ride Indian bikes, off-road vehicles, snowmobiles and slingshots through Polaris Adventures, which was a rousing success in its first full year. With over 90 locations already active and over 35,000 rides taken, we’re exposing a new and diverse set of customers to the fun and excitement of exploring the outdoors on Polaris vehicles. When we acquired Boat Holdings, we gain access to the 70% of the water of the world that is water, as well as large and growing segment of consumers who enjoy it. The integration of Boat Holdings is on plan, Bennington is set for another strong year and our other boat ramps offer significant opportunity for growth and margin expansion. Accelerating global growth requires that we extend the fine and benefit of Polaris products to customers around the world. Indian motorcycles is driving growth from Europe to China and our modern factoring in Opole, Poland is expanding opportunities for off-road vehicle growth. Our commitment to safety and quality covers the entire Polaris enterprise and we once again posted outstanding employee safety metrics. The dedication and process discipline of our 13,000 employees drove higher quality and lower warranty costs, and supplier quality improved notably as well. Quality and productivity go hand in hand and our strategic sourcing project is creating the foundation and capability for Polaris to sustainably lead in these important metrics. We are in the later stages of the first wave of our strategic sourcing efforts and the value improvement is on track, but the work to achieve these results is significant. We anticipate the investment versus saving balance will shift our way in the second half of 2019. Rising tariffs are an unfortunate reality we must consider in our strategic sourcing efforts and deal within our business. The various 232, 301 and retaliatory tariffs are not well understood by many, but they all impact our operations. The most significant and disparate impact involve the 301 List 3 tariffs, which are still in place and factored into our outlook. There is currently no legal framework to claim an exemption to list three, but rest assured we are working every possible angle to be at or near the front of the line if and when it is authorized. While there is risk of the 301 tariffs going from 10% to 25%, my belief is that the economic damage to the U.S. economy would be too great for that to happen. And therefore, if it did, we would be more concerned about the indirect impact on consumer demand than on the tariffs themselves. As a reminder, although, we only directly source about 15% of our parts from China, we never less pay a large tariff penalty that our foreign competitors avoid, only because we employ thousands of American workers to assemble these parts. Ironically, if we produce all of our vehicles in Mexico or Canada, we would be exempt from 301 List 3 tariffs. Our comprehensive efforts to obtain relief are ongoing as we closely monitor the latest negotiations. But our best assumption for 2019 budget is that List 3 will remain at 10%, which is driving most of the $80 million to $90 million increase in tariff cost that we expect. While arguing for just tariff relief is a key part of our strategy, we are doing much more to minimize the impact. We limited tariff costs in 2018 by successfully mitigating the pass through from our suppliers and we will redirect shipments when it makes economic sense. Our price increases, which took effect on January 1st, partially alleviate the tariff impact and we will continue to take measured action to further offset and limit such costs. The best possible outcome would be for China to agree to more equitable trade practices and sign a true and fair trade agreement. We want but do not expect that outcome in the near term. I will now turn it over to our Chief Financial Officer, Mike Speetzen, who will update you on our financial results and plans for 2019.

Thanks Scott and good morning, everyone. This morning I will spend some time on our 2018 results and then move on to our 2019 guidance. Fourth quarter sales were up 14% on a GAAP and adjusted basis versus the prior year with Boats adding $145 million of sales. Organic sales, excluding Boats, was up 4% in the quarter, driven by higher sales of snowmobiles and higher average selling prices, partially offset by lower shipments of off-road vehicles and motorcycles due to tough compares to Q4 of 2017. Average selling price excluding Boats was up 6% during the quarter, driven by the mix of products. For example, we shipped the majority of our high-priced preorders SnowCheck snowmobiles in the fourth quarter of 2018. Fourth quarter earnings per share on a GAAP basis was $1.47. Adjusted earnings per share was $1.83, up 19%, driven by volume, the Boats acquisition, operating expense leverage, lower share count and a lower tax rate. Our EPS growth was muted by ongoing tariff costs and increased logistics and commodity costs during the quarter. For the full year 2018, sales were up 12% on a GAAP and adjusted basis versus the prior year. Boats added $280 million or 5 percentage points to the growth versus 2017. All segments except motorcycles grew for the year on a GAAP and an adjusted basis, including an increase of approximately 4% in average selling prices. Boats also grew year-over-year a pro forma basis. Full year earnings per share on a GAAP basis was $5.24. Adjusted earnings per share was $6.56, which was in line with our expectations. The 29% increase in earnings per share was driven by a combination of increased volume, the Boats acquisition, operating expense leverage, a lower tax rate, partially offset by higher tariff, logistics and commodity costs. Gross profit margins on a GAAP basis declined 170 basis points for the fourth quarter and increased 30 basis points for the full year. Gross profit margins on an adjusted basis were down 190 and 80 basis points for the fourth quarter and full year 2018 respectively, reflecting tariff, logistical and commodity costs and a negative product mix. We have provided more details on gross profit margin performance for 2018 that can be found in the supplemental section of this presentation. Turning to our segment performance. ORV/snowmobiles segment sales were up 7% in Q4, driven by snowmobile sales. Snowmobile sales were up almost 50% year-over-year due to the timing of shipments of our incredibly successful SnowCheck program. ORV sales were down slightly in the fourth quarter due to a difficult compare to last year. Average selling price was up 7% for the ORV business, but it is important to note that although our average selling price increase, tariff, logistics and commodity costs, along with negative product mix put downward pressure on our gross margins. For the full-year, ORV/ snowmobile segment revenue was up 10%, driven by all categories. Average selling price were up 5% for the full year. Motorcycle sales decreased 15% on a GAAP basis and 13% on an adjusted basis in the fourth quarter. Indian sales were up slightly, but more than offset by the decline in Slingshot sales. Full year motorcycle sales declined 5% on a GAAP and adjusted basis. It's important to note that the decline in sales for the year was driven by heavyweight Indian motorcycles and Slingshot. Our midsized bikes have very strong growth and gained considerable market share both on the quarter and for the year. Although, the market remains weak, Indian continued to gain share in the fourth quarter and full year of 2018. Global adjacent market sales increased 4% in the fourth quarter. Average selling prices were driven down 7% due to the timing of defense shipments, which typically have higher ASPs. For the full year, global adjacent market sales increased 12% with all business lines growing. Aftermarket sales were down 3% in the fourth quarter, primarily due to a decline in TAP sales. TAP weakness resulted from lower demand in our wholesale and e-commerce businesses. Our other aftermarket brands continued to outperform with sales growth of 13% in Q4. Full year aftermarket sales were flat with 2017. Our Boat segment reported sales of $145 million for the quarter in line with our expectations and integration plans remain on track. Sales increased approximately 5% on a pro forma basis versus Q4 of 2017. Our international business continues to grow with sales up 3% for the fourth quarter, up approximately 7% when you remove the unfavorable impact of currencies. Growth was driven by the EMEA region with sales up 6%. Full year international sales were up 11% versus 2017. Our Parts, Garments and Accessories sales increased 6% during the quarter and 7% for the full year. Before I move on to 2019 guidance, let me briefly touch on dealer inventory, which was up 1% versus 2017. As you will remember from our previous call, we had dynamics between the quarters when comparing 2018 with 2017 in terms of shipments, product availability and associated dealer inventory levels. As we discussed, it's important to look over the past couple years. When doing so, you can see from the chart on the right that ORV dealer inventory levels are up a nominal amount from 2016. During that same two year period, the Company's North American retail and shipment performance were closely aligned. Looking at this extended period compensates for any outliers and quarter-to-quarter shipments and normalizes for the implementation of side-by-side RFM. Now, moving on to our 2019 guidance. We expect total company adjusted sales to be up in the range of 11% to 13% versus 2018. The 2019 sales growth includes the following assumptions. The overall powersports market is expected to grow low single-digits percent with the off-road vehicle market growing, particularly side-by-sides and the motorcycle market continuing to decline. All of our segments are expected to growth, driven by strong market positions coupled with leading innovation. We anticipate average selling prices to increase as we innovate, add features and contend with higher input costs. As many of you know, we initially roughly 3.5% increase in both our ORV and motorcycle businesses at the start of this year. Additionally, the boat segment will add considerable sales as we anniversary the acquisition from last year. And lastly, foreign exchange is expected to negatively impact sales by 1%. Adjusted earnings per share for 2019 are expected to be in the range of $6 to $6.25 compared to the full year 2018 adjusted EPS of $6.56. However, when you peel back the layers a bit, our performance is significantly better than guidance suggest, which I'll view in more detail shortly. Moving down the P&L, our 2019 earnings per share gains assumes the following. We anticipate that gross profit margins will be down on an absolute basis, driven by tariffs and currency. Operational improvement of 80 to 110 basis points is included in this guidance. Adjusted operating expenses are expected to be up in the mid-teens percent range in 2019, up 10 to 20 basis points as a percent of sales. The increase is related to ongoing investments in research and development expense, which are increasing in the high-teens. The addition of operating expenses from the Boat business, added expenses related to the new multi-brand distribution center in Fernley, Nevada, higher variable compensation costs and the costs associated with the summer dealer meeting where we'll be celebrating our 65th anniversary. Income from financial services is expected to be down high-single-digits percent, driven by an expected lower retail penetration rate in 2019 from a company high of 35% realized in 2018. Additionally, dealer inventory turns are expected to continue to improve as RFM process matures, which is anticipated to lower the income from the Polaris Acceptance JV. Interest expense will be up about 40% given the debt taken onto finance the Boat acquisition, as well as two anticipated rate hikes. The income tax rate is expected to be approximately 22.5% for the full year 2019, slightly higher than the 2018 rate, driven by lower assumed option exercises. Share count is expected to be down slightly. And lastly, currency is anticipated to negatively impact 2019 pretax profit by approximately $30 million, largely due to the Canadian dollar in Europe. We plan 2019 assuming the average euro to USD at a $1.12 and the CAD to USD at $0.74. We have hedged 50% of our anticipated Canadian dollar exposure in 2019. While this partially protects our cash flow impact from transactional activity, the company is still exposed to the translation effects of currency movements, as well as the un-hedged portion of transaction impacts. From the EPS standpoint, you can see that before the external factors of tariffs, currencies and interest rates, the company is expected to generate a 14% to 18% increase in earnings. This reflects the progress the team continues to make in driving efficiency and productivity to leverage improved earnings on our revenue growth. Our 2019 guidance assumes that our earnings are lower on an absolute and as a proportion of the year in the first half given the impact of tariffs and FX. While first half sales are anticipated to increase, given the addition of Boats, the additional income is more than offset by tariff and FX impacts, as well as the ramp-up in R&D spend. As historically the case, our first quarter will be the smallest quarter of the year. We anticipate Q1 sales growth of approximately 15%, including Boats and expect earnings to be down 15% to 20% because of the factors I just discussed. You will notice that we have summarized gross profit margin below the EPS chart. Before the effects of tariffs and foreign exchange, our gross margins are trending favorable to 2018 by 80 to 110 basis points, driven by volume, price, improved quality and productivity. Wave one of our strategic sourcing project will begin to yield savings in the second half of 2019. When factoring in the anticipated impact from tariffs and currencies, we are expecting gross profit margin pressure. We have assumed that China 301, List 3 tariff rate holds at 10% for the entire year. Based on these assumptions, adjusted gross profit margin is expected to be down 60 to 90 basis points from 2018, including approximately 170 basis points of combined tariff and currency headwinds. If the China 301 List 3 tariff increases 25% effective March 1, we will be facing approximately $60 million more in tariff headwind, which equates to about $80 million on a full year run rate basis. This is not accounted for in our guidance. Sales guidance for our segments is as follows; ORV/snowmobiles sales are expected to be up mid-single digit percent with snow up double digits percent and ORV and PG&A sales up mid single digits. Motorcycle sales are anticipated to be up in the mid-teens percent range driven by new products. Global adjacent market sales are expected to be up mid single digits percent with growth expected in all product lines. Aftermarket segment sales are expected to be up mid-single digit percent with improved growth expected from TAP. Lastly, the Boat segment sales are expected to be more than double as we anniversary the purchase of the acquisition. On a pro forma basis, the Boat segment is anticipated to grow in the mid-single-digit percent range. On a segment reporting basis, our ORV/snowmobiles and motorcycle segments are hit the hardest by tariffs and foreign exchange with 2019 gross profit margins expected to be down. However, excluding tariffs, all segments' gross profit margins are expected to improve over 2018 on a comparable basis. We've included additional gross profit margin details for 2019 in the supplemental section of this presentation. Operating cash flow finished 2018 at $477 million, down 18% driven primarily by hiring factory inventory due to the timing of shipments and inventory required to effectively meet RFM delivery times. We anticipate 2019 operating cash flow to be up approximately 20% to 30% for 2018 due to improved working capital efficiency. Our capital deployment framework remains consistent. I would point out that we anticipate a higher level of capital expenditures, which includes tooling, given a number of new products and development and is slated to come to market, as well as the completion of a distribution center outside Fernley, Nevada. We have acquired a number of strategic assets that have and will help drive profitable growth. While our debt to capital ratio is 69% and it's well within the company accessible levels, we will look to accelerate debt reduction in near term when possible. We repurchased 3.2 million shares of Polaris stock in 2018. We have approximately 3.3 million shares remaining under the current board authorization. We will be opportunistic in executing share repurchase, which will be balanced with our desire to reduce the debt level. Lastly, we continue to have returns on invested capital that is more than double the average of the S&P 500. With that, I will turn it back over to Scott for some final thoughts.

Thanks, Mike. A year ago on this call, I spoke about an improving global economy and it is in understatement to say that a lot has changed since then. We’re planning for slower growth to mostly stable economic environment, but we're also attracting rising risk of recession and making plans to avoid being surprised when it occurs. Tariffs and higher interest rates put pressure on the economy and the former even more so on Polaris. Currency headwinds are further exacerbating our pressures so the team is working full-time on counter measures to mitigate these impacts. Fortunately, the underlying business is operating as well as it ever has. The long-term savings expected from our strategic sourcing initiatives while eventually more than suffice to offset the aforementioned headwinds, but not in 2019. Our cross functional sourcing teams are working extremely hard and getting tremendous knowledge, which is why the future savings and value improvement will be so great and sustainable. We project a return to growth for the powersports industry with side-by-side's leading the way. Polaris will celebrate our 65th anniversary this summer, and it would be a fair guess that our product innovation maybe dialed up a notch or two. We remain very bullish on our entry into the boat business and our teams are identifying new ways to compete and win. We especially like the pontoon segment and our strong relationships with the engine OEMs gives us great options for our customers. We do not plan to pursue any major acquisitions in the year ahead, but we will invest more in ourselves. We will fund several large strategic bets ranging from the increased research and development programs, factory choice initiatives to better methods of engaging and interacting with our customers. The future for Polaris is incredibly bright. We just need to get there fast. With that, Will, would you open the line for questions?

Thank you. And we will now begin the question-and-answer session [Operator Instructions]. And the first question will be from Greg Badishkanian with Citi. Please go ahead.

Scott, I think you mentioned some retail slowdown in the second half of December and then things recovered in January. So I'm just wondering maybe what really -- did anything stand out in December, or was it just the stock market volatility or something else any segment or region that was stood out as well? And then is business back to normal now in the end of January.

Greg, I'll tell you, we had a really strong October and November, and really that momentum kept going through the first half of December. And it wasn't Polaris, I mean, it's across many retail businesses and most everyone I have talked to. Some of the banking businesses that I know quite well are also said they saw the same slow down in the second half of December. What we believe is that it was mostly people looking at their 401(k) balances their investment balances and saying it's not the time to go invest in a new RZR, Ranger, or Indian motorcycle and that seems to be what it was. I will tell you we are very encouraged with the trends we have seen in January continuing so far. So it appears to be an anomaly right now and I'm glad to see that the recovery was as good as it was. But you know we've got 11 months and four or five days to play out.

And just on Polaris and Northstar, what's been the customer response? And I know scarcity is always good, it always helps the brand. But how comfortable are you with your inventory availability of that line as we are in early 2019 right now?

We are really proud to build those ranges in our Huntsville facility. And John Dan and his team there have done a great job of ramping up production capability. One of the opportunities we have is we have limited the number of colors you could get that in. So I think demand is actually going to increase as we expand the color options. But really the work that Ken Pucel and his teams have done to create the flow of products through RFM, we are quite comfortable that we will be able to meet demand for the Northstar additions. I mean obviously with this kind of weather, it’s a pretty good option.

And the next questioner today will be Robin Farley with UBS. Please go ahead.

I appreciate that there is a lot of uncertainty around the tariff issues. But maybe just to understand like a best case worse case. And I think in your opening comments you did mention that if List 3 goes to the 25% that will be $16 million more incremental, so that was helpful. I guess just thinking about what could go better than the guidance you are giving today? The slides mention, at least one of the slides showing the incremental impact from tariffs says like before counter measures. So is your guidance today including no counter measures to offset the incremental tariff impact in '19? And what could that look like?

Our guidance includes all of the known countermeasures that we can pursue. So there's nothing -- don't think that there is upside if we implement countermeasures, because we put in anything that we think we can do. The best possible scenario would be when they reach the upcoming deadline that they agreed to take the tariffs off that would be the best possible scenario. You would also have to get rid of the 232 tariffs, which has a retaliatory impact of us shipping bikes into Europe, but we don’t see that happening. Therefore, we've given guidance with what we think is the most realistic view. The second best alternative would be we could be successful with our efforts to get relief, which would be the equivalent of having the tariffs go away. But we also are not yet confident in that, although, we will continue to work that very hard. Mike, do you want to add any different color on the numbers?

I think Robin, just so you understand how we build this up. I mean you will notice that our 2018 impact was about $10 million less than we had been indicating, and a lot of that is really just around timing. Scott pointed out a small portion of our purchases come from China. But obviously with the significant tariff on that’s a huge impact. And when you break that down, there's a fair amount of it that’s indirect, meaning its coming through another supplier and so the tariff ultimately passed on to us. So we have to make assumptions around the timing, and so that’s an area of variability. Tim’s team has been very successful at stating that off but we know that there's a reality that as these things remain in place that’s going to continue to hit us. And so we've got the tariffs ramping as we go through the year and essentially what I would call it full run rate by the time we get into the second half.

And then just maybe one last quick one, just if you had any thoughts on the pontoon segment, it's been growing nicely the last couple of years. And I think you indicated although your business grew that the industry declined in Q4. Is that anything worries you about the pontoon industry?

Q4 is not a quarter to worry about anything trending wise. And we feel very good based on the orders that have been taken at the recent boat shows and the line-up that we have. We were a little bit light on some of the lower end less expensive models, previously with Bennington and we feel like we've got those lined up. And again, the relationship that we have with Yamaha and Mercury, we still believe gives us competitive advantage in pontoons.

And our next questioner today will be Jaime Katz with MorningStar. Please go ahead.

I’m curious about your thoughts on motorcycles, and particularly Slingshot to start with. I think either on the last call or the call prior, it sounded like you guys expected that to start turning around maybe mid 2019. I am curious if that’s still on track? And if it is or isn’t, how confident does that make you guys in the mid-teens shipment outlook, because the sentiment that was echoed on the call of your competitor earlier this morning was that the market still remain very week. And I understand there is innovation. But it seems like there are other factors that might be headwinds in that segment. Thanks.

Jamie, I will tell you Slingshot is -- it hasn’t lived up to our expectations the last couple of years. I'm really proud of the work that Steve Menneto and Josh and the team are doing to understand really what's driving the underlying lack of demand. I will tell you the plans we have in place, both for execution and product development are we're very encouraged by. We believe that is we’re going to take that knowledge that we've gained and apply it throughout the year. And we expect '19 to be a better year and then '20 as we continue to the product innovation to be better yet. So not our best effort on execution thus far but we are smarter and better, and we do expect to have improved performance in '19 with Slingshot.

And then for the strategic sourcing initiatives you guys have been working on, I know it’s a multi-year effort. Are there any important key focuses we should know about in the year ahead or in the next stage that would be helpful to be aware of? Thanks.

I think, Jamie, it's important I mentioned in my prepared remarks that we've got savings built in. I think what’s important to understand is we’re not just executing on wave one we’re actually going to be initiating the next couple of waves. So we do have incremental costs associated with that. And a portion of the R&D increase that I mentioned is really dedicated to the project, because as you can imagine as we start to switch suppliers, there's a fair amount of validation work that has to go in when we're off cycle from model year change over. So there's a fair number of moving parts. The good news is we're making great progress. We're really encouraged with what the teams have been coming back with in terms of the quality of the suppliers, as well as the savings impact. And so we feel really good about that project moving forward.

Yes, I'll just add Jaime that what I've been most impressed with is the knowledge and sustainability that we get with this process. I mean, it's extremely rigorous and it's also extremely hard, and that's why it's taking so long. But as we work through the wave one the savings will start showing up in the second half and we'll start wave two here shortly. But as we work through the five or six waves to get through the entire Polaris portfolio, we're very confident in achieving the large savings number that we project.

And our next questioner today will be Tim Conder with Wells Fargo. Please go ahead.

Gentlemen we've since been talked about that you're pursuing other things on the List 3 mitigation other than the exemptions, which I think Lighthizer said that should the trade talks failed and they'll put in a List 3 process. What are those other things? Is it we want to use the term exclusions or was there another path other than exemptions or that the tariffs are just dropped as part of the trade deals overall?

I mean, Tim, obviously, we believe that the best approach is a negotiated deal. But if that doesn't happen, we do believe that that Lighthizer and the team will ultimately open up a process to get an exemption. And what we're arguing for I think what you're referring to is really not a Polaris exemption. We're not trying to just help Polaris. We want to make sure that the powersports industry and the thousands of people that are employed in the dealerships in the suppliers throughout the industry are taken care of. Now truthfully, since we're the only one with any significant impact, we're the ones that benefit the most from it. But I think that may be what you're referring to. And we've got a very good lobbying effort. Ellen McCarthy leads our team in Washington and we are working extremely hard. Ultimately, we were probably closer to getting an exemption before they started the negotiations and now we have to wait and see what happens with the formal negotiations. But trusted we are working extremely hard to make sure that we get more fair treatment than that’s happened so far.

And on the motorcycles gentlemen I just wanted to follow-up on that; one, the completion of Indian for the EU market, getting that to pull on any remaining costs; and then, Slingshot, you got some new things coming you alluded to that Scott here in response to the prior question. How much time, let's just say those don't work. How much time realistically or rope did you give Slingshot here and say, hey, we tried a good product, whatever. How much time do you give that? And lastly, Mike, goals at year end 1920 on leverage?

That was an effective second question.

I'll start with Slingshot. We're not going to talk about future product plans. I will just tell you that we've learned what customers want. We're going to address that. We feel very good about that. Truth be told, Tim, I think most of the issues with Slingshot are more execution issues on things that we have done wrong versus things that are wrong in the market. We know the people that like to have it really like it and it's our job really to make sure we reach more of those people. So we're not -- and I mean I will remind you when we launched Ranger 20 years ago the first few years were pretty darn painful. And if we had pulled out early, we would've missed a very large business for us. I'm not suggesting that Slingshot could be that big, but I’m suggesting that there's an opportunity for it to be a profitable growing part of the business over the long-term, and in the next several years we will make sure that happens.

So Tim on the Poland additional ramp up for Indian and everything is going as planned. You can see from the tariff chart though that we have the retaliatory tariffs as a portion of the stack bar. I mean on the relative basis to the total, it's small but relative to that business it's pretty large part. Because even though we get ramped up, we will miss seasonality if we don't start shipping bikes and they're made in the U.S. So obviously, we feel good about the ramp up but we’re going to end up having additional tariff impact at least this year assuming the retaliatory tariffs stay in place. From a leverage standpoint, we ended about just around two and half turns coming out of 2018. I definitely emphasized in my prepared remarks that we're in a position where we want to try and get that paid down. We've been pretty consistent with saying two to two and half times. And then obviously, we want to want to keep an eye on the economic landscape and make sure that we're positioned really well to be in a position to handle if a downturn were to happen in the out year. So we'll remain focused on at least maintaining that level of leverage of not bringing it down.

And the next questioner today will be from James Hardiman with Wedbush. Please go ahead.

A quick clarification on my favorite chart in the deck, which is Slide 15 to have the earnings log, Robin had asked a question about how the measures. I just want to make sure I understand. The dollar or the $80 million to $90 million that’s before countermeasures, I’m assuming the countermeasures is in the $0.60 to $0.75 of benefits that you're showing there. Is that how they work?

There's a couple of things, James. I mean, one if you remember last year, we actually talked about price relative to tariffs, because we were trying to take evasive action at that point in time. We've stopped talking about that, because our price increases are covering a number of different things. First and foremost, it’s the features and the quality adds that we've made to the vehicles and then obviously, we're dealing with higher commodity logistics and tariff costs. And so there is a small portion of the price increases that’s on the left-hand side over in those green bars. So if in the position where tariffs were to go away, is there a portion of the price that we'd have to get back. Yes, it's probably a very small, small piece of that that we’d probably get back through promo, but that would be the primary one. As it relates to the other activities where we've been stating off the increases and pushing hard on not just excepting what the suppliers are coming in with that’s already included in the dollar bring down on EPS.

And so is there a net number for that dollar that include countermeasures?

With it's a dollar with all the countermeasures with the exclusion of pricing, as I mentioned, it's hard to carve out the piece of price, which would be relatively tariff. So that’s why we've steer away from trying to do that. I mean our goal would obviously be to try and hold on to the price if the tariffs were go in that way, but we will have to reevaluate if that happens.

That’s exactly where I was getting at. And then probably too early to update I mean obviously you gave us the five-year plan a year ago and a lots happened since a year ago, most notably the tariffs. But in the context of your 2019 guide, any update to that 15% CAGR through 2022?

James, I think we've spoken quite extensively about what we expect to see out of our strategic sourcing initiative. That is the biggest chunk that we're going to get towards that goal. Obviously, we've got several businesses that we expect significant margin improvement, and I would say motorcycles are in that category, cabs in that category, we see lots of opportunity with boats. So, we wouldn’t have put that out a year ago if we didn't think we were going to be able to hit it.

And our next questioner today will be Craig Kennison with Baird. Please go ahead.

Mike, I think you had mentioned in the context of leverage that you want to be prepared for the next downturn. Maybe just walk through what you have done so far to prepare for that inevitability and maybe frame if you can the margin or the decremental margin associated with revenue in a downturn?

It’s a good question, Craig. I mean Scott and leadership team and I have put together an architecture, so that when that and inevitably happens, we have essentially what we termed playbook to go by. And we've set certain principles. Number one is that we want to preserve liquidity in the company and make sure that we managing any debt load that we have. And obviously between now and whenever that time comes, we will make a concerted effort to continue to pay that down. The second is we want to preserve the strategic investments. If you think back to what happened during the '08, '09 downturn and the reason Polaris came out of it so strong and moved into such a significant market share position is we didn’t cut back on some of those vital investments. So we've made some very clear lines of demarcation. As for the decremental margin, tough to say it depends on the size and scope of our downturn. I think it's safe to assume if you compare us back to where we were in '08, '09, we're very different business. Our fixed cost base is larger. We have more factories than we did at that point in time. And the profitability coming off some of our larger vehicles, like the RZR are much higher than they were back at that point in time. So the decremental margins would probably mirrors something like what we saw back in 2016 when the business went down about 5% to 7%, and that's essentially the way we've modeled it with the associate countermeasures that we would go after again preserving all the strategic important initiatives that we have in the company.

And the next questioner today will be David Beckel with Bernstein Research. Please go ahead.

Just wanted to took a Part D gross profit flow through a bit. Are you expecting or I think in prior calls you said you expect about 35% gross profit flow through. Is that consistent with your expectations for 2019 as well?

So if you look at that EPS bridge that James was referring to earlier and you look at what we're getting in terms of 9% to 11% flow through, let’s call that about $400 million to $450 million in revenue. If you backward calculate that, it's going to look like a pretty low drop rate. The reason being is that we have buried within that the R&D increase that I talked about earlier, which is in the high teens. I also mentioned I think when Jamie asked her question about our Gibson project. We have incremental costs associated with the engineering work to validate those savings. And then we've also got the addition of the Boat business, as well as long-term incentive plans that the prior three years have basically been almost zeroed out, and we’re now accruing those essentially to full payout. So when you strip those things out, the volume that's coming through is in the 30% and 40% range, which is exactly what we would expect.

And the second question for me just wanted to touch on the Adventures a little bit. It sounds like it's been a huge success for you guys. What are you anticipating in terms of sites and rides for 2019 if you know as of yet? And I was also curious to what extent are you seeing any conversion or new customer adoption from that business?

We are really proud of the work that the team has done there, expanding as rapidly as they have, just building a plug-and-play model for these best operators. And that’s what we are doing is just continuing to sign up the best operators in every part of North America that we can find. So I think the rapid rise to 90 was good. And I think you could expect almost a pace like that to continue as we move forward. But being very diligent on making sure we are only adding the best operators. The conversion rate is the single best marketing tool we have. I mean, I love our digital marketing efforts, I love some of the campaigns that Indian motorcycles has, but there's nothing better than butts and seats to sell our product. So as we get people riding our products, ultimately they come in and convert. And it's a low single-digits number right now but that low single-digit number overtime as we expand that business will ultimately be helpful. So we are very encouraged by the business itself, but also the opportunity it has to drive future sales.

And our next questioner today will be Gerrick Johnson with BMO Capital Markets. Please go ahead.

I have two questions. The first question on side by side. Who do you think you are getting share from there?

It depends on categories. But clearly, I think we have gained mostly from the Japanese over the last year or so. Our competitor that was recently acquired continues to seed share to almost everyone, so that's been helpful. But no, we feel good about our portfolio. And I'd tell you with the Turbo S launch, with Ranger XP1000, I mean we have got the best products at almost every segment right now. Where we lost a little bit share is Trail where we don't have a new product entry, and I think that's just the reality we live in right now but we feel good about our share position. And returning to share growth in side-by-side both for the quarter and the full year, we will take that. There is I think concerned about somebody building a plant that we couldn't possibly grow in that environment surprised that we were able to do that really.

And also on adjustments for 2019, our favorite question here. Will there still be Indian wind down, will there still be Eicher and then amortization what are we backing out each quarter for that?

I think about Victory, there will not be -- we do not believe there will be anymore Victory wind down. The EPPL business is essentially effectively shutdown. The Indian facilities down and dealerships down in Brazil have been wound down successfully. I think going forward aside from the intangible, the only adjustments that we are going to end up having will be any acquisition costs that we have and then probably some of the restructuring costs and legal costs. But they should be much lower and much smaller than what we have had historically.

And the next questioner today will be Joseph Altobello with Raymond James. Please go ahead.

I just want to go back to tariffs and James question earlier. I think you mentioned the dollar per share of incremental tariffs this year includes the benefit of supplier negotiations but not pricing. Is that correct?

Correct.

And how much were you able to extract from your suppliers, was it meaningful?

Yes, I mean it's hard to say. I mean, the sourcing guys, it was considerable, both in terms of being able to delay, as well as pushing back on the suppliers. You can imagine an environment where we've got tariffs. They use that as a shield to come in and look for price increases to help cover many of the things that we're dealing with as a company in terms of labor increases and logistics and other commodities. And Ken's teams put a really good process around making sure that we stave off that, as well as pushing back on the suppliers. Given what's happened with China currency, as well as the desire for them to retain us as a client, we've been successful in getting them to share in portions of that. But we're not at a point where we want to put a qualification around that.

And then secondly, you mentioned the 3.5% whole goods price increases you guys took in ORVs and motorcycles January 1st. What's been the competitive response? And I know it's early but you pointed out a number of times your competitors do not have the same headwinds that you guys have from the tariff perspective?

Yes, so far we haven't seen much from a competitive response. And I will tell you that our margins are generally better than most of our competitors, so they should take advantage of the price. But we can't. I mean, it's actually not a good idea for us to talk about what competitors might do. So, we'll see. We feel good. Again, ultimately, it's a price value equation. And we talk about price related to tariffs. But really a lot of the price we're talking about is the incremental product benefit that we're bringing out. I mean, I'd tell you, again, I think so everyone brought up the Northstar edition earlier. I mean, it is a phenomenal product with a lot of content to make it such. And therefore, part of the price is just making sure that the value that we're bringing to the dealers and our consumers with the vehicles is being taken care.

And our next questioner today will be David MacGregor with Longbow Research. Please go ahead.

Scott, can you just talk about what you've learned regarding ORV customer sensitivity to rebasing promotions to the time when financing rates on the rise and how monthly payments are going up. Is the customer maybe expecting more in the way of promotion now? And if so, how you maintain pricing discipline in the face of higher financing rates and an increasingly promotional environment?

What we've learned about promotion in general is that if we work more closely with our dealers and manage promotional execution by region and certain customer needs and buy products, we can be pretty careful with price impact or what not. There's a segment of our customers that are very monthly payment driven and we use promotions to manage that. There's certain customers that want more accessories or just want the dollar rebate on it. So we've got a very sophisticated process for dealing with that. And I think it actually it plays to our advantage as interest rates rise where we have this more sophisticated tool that we can deploy to give people the optionalities they want with promo.

And I think, David, just to reemphasize Scott's point. You heard me in my prepared remarks talk about our penetration rates got up to a company high at 35%. So that comes through financial services income below the line. But the reality is that we are putting higher promo in associated with that. So the point being that where we see rate sensitivity, we've got the ability because of the strength of the retail partnerships that we have with three great firms that we can put promo dollars to it. But because we share and the returns they make on those customers, we end up making a substantial portion and if not all of that back, it's accounted for in two different lines.

And then second question is just how are you dealing with increased levels of online competition within the aftermarket business. And are the stores comping positively? And how much of the 2019 mid-single-digit growth is coming from online sales?

The online sales, actually, we feel good about it. We did what we call the ATG transition at that TransAmerican Auto Parts where we switch to a better Oracle platform, which ultimately be a nice competitive advantage. In the near-term that is not all that helpful to us because you've got to reprogram all the algorithms. But we feel good about where the online business sit. I will tell you the marketplaces that we have with Google and Amazon are very, very good for both cap and for our other aftermarket businesses. And I think we're taking good advantage of that. Same-store sales we're not as good in the fourth quarter, but they're trending well in January, this is talking to about TAP related trending well in January. And we expect we should have a good a year there. We've got Craig Scanlon and the team there, I've got a very good plan for that omni-channel business. And ultimately, we think the strength of TAP is that ability to sell online and through the stores.

And the next questioner will be Seth Woolf with Northcoast Research. Please go ahead.

Scott I loved the college football playoff reference, it's very appropriate. So I guess just a couple things starting off, first, wanted to talk about the ORV. You talked about mid-single-digit increases for the year. You're getting an ASP benefit. And if I recall correctly, you said low single-digits is kind of your market expectation in 2019. Did I hear you correctly?

Yes, and that's a change. We haven't seen industry growth rates in a while. So I think that stabilization is a positive sign.

How should we think about what you guys are able to do, because especially compared to us some of the competitors you have, a lot of products in Mexico. The price increases that you've had to pass along to cover the tariffs is going to be a bit of a headwind?

Well, I think price elasticity of demand would suggest that that's true.

So then, I mean, how should we think about Polaris, is it flat, is it down low single digits next year?

I think what, Seth, what you're trying to do is correlate against the market backdrop. And I think you can surmise by ORV be in mid-single-digits with price being in there that we're essentially tracking to the ORV market, the industry. So not saying necessarily a lot of share movement and obviously, we'll have a different view of that internally as we push the teams. But I'd also point you back. I mean, our ASPs have been up over the past couple of years in the face of a new competitor coming onto the scene very strongly building a lot of capacity. And so we have demonstrated that capability being more premium price to continue to not only battle back but to continue to take share. And so we've been a little conservative in the way we planned for that going into 2019, but we'll be certainly pushing the team's harder than what we've got in the guidance.

And I'll just, I mean brands matter. And we are reinforcing Chris Musso and the team are doing a really nice job with Sportsman, Ranger, RZR in general to making sure that we position those brands appropriately. And ultimately when you've got great products, strong brands and good distribution that's a pretty nice combination to win in this industry.

And our next questioner today will be Joseph Spak with RBC Capital. Please go ahead.

I just want to go back to CapEx for a second. There is a comment that you guided higher next year for a variety of reasons. I believe if you went back to the beginning of this year, you also got it higher, it came in higher. But I think if you look at the assumptions at the time, it seems like it may have -- or you may have been fill up that, it would have been even higher this year. Is that -- A, is that accurate; and B, is that just some projects that were push and reason why '19 CapEx higher? And then just continuing on that line of thought, I think you said Boats isn’t really capital-intensive. But I'm curious as to what you think CapEx to sales over time looks like now for Polaris with Boats?

So Joe, you actually picked up on something that I mentioned it in my prepared remarks but probably not strongly enough. The Fernley distribution center, we had anticipated was going to be fully run through the system in 2018. When we did the original plan and then as we got further along, we realized that the capital would be more of a 2019 recognition. So there is a shift of that. 2018 came in at about 3.7% of sales. And right now, '19 is probably in that same range up to 4%. So number one, it’s the shift to the Fernley distribution center. The second item is we obviously have a fair amount of tooling. And when we continue to ramp our R&D spend, the tooling associated with lot of the new products that you'll see this year, as well as in the next one to two years is obviously playing a big part of that. Now this sourcing project that we've referred to now for a couple years one of the goals of that is to try and take that capital spend down and really have our suppliers co-investing with us. And so we do think that’s going to be a lever. And I think over time you will see us be able to get the business down to say 3.5% of revenue.

And just one more bigger picture question with some of your competitor announcements. I mean, you guys have had some early initiatives on electrification with motorcycles. It seems like maybe you backed away from some of those initiatives. At least I think initially it was [in-house] Victory and I don’t know if some of those projects were moved over or not. But where do you stand on that opportunity for Polaris?

I was proponent of our efforts with Brammo, which was ultimately it became Victory Electric Motorcycle. What we believe is that the right time to enter the electric market is when there is large consumer demand, the opportunity is for us to make money and the performance and weight and cost, all of that equation come into one. We've got out of it because we couldn’t find that equation and we're not yet prepared to enter back into it until that exists. I mean, I think if you look at automotive, for example, and you know this better than anybody, there is not a lot of folks making money with it. And we're just not -- we have a team focused on it, we have capability building for it. We’re not going to enter the market until we can make money at it.

And our last question today will be from Michael Swartz with SunTrust. Please go ahead with your question.

Just a quick question on recent Larson acquisition, I think it's pretty small. But any framework around size and I guess how that fits with your strategic rationale of going into Boats and expanding that business?

It's a bit ironic. I think that ranks up there with one of the smallest acquisitions we've ever done and it's probably got more coverage than we've got when we bought Boat Holding. So interestingly though what we like about it strategically is it gives us access to the fishing market, which we didn't previously have with our other brands. On a size basis, it's about the same size as our Rinker business, which is relatively small. But for us it was just a very cost efficient way for us to enter the very attractive fishing segment. And I think we feel good about our ability to take that and grow it profitably along with our other Boat brands.

And then just quick follow-up and up with the price increases going through in motorcycle and ORV on January 1st, I'd assume just given your commentary around pulling back shipments towards the end of the year that there wasn't any materials buy for or pull forward there?

No.

Okay. We want to thank everyone for participating in the call this morning. And we look forward to talking to you in next quarter. Thanks again. Good bye.

The conference is now concluded. Thank you for attending today's presentation. And you may now disconnect your lines.